Zulauf: 20% downside risk from the market’s intraday May high
Point for point, I agree with the commentary from Felix Zulauf in this week’s Barron’s mid-year roundtable discussion. For long-time Credit Writedowns readers, you will recognize almost every one of these points from previous posts. It is nice to see it all distilled so cogently in one place.
- “The global economy’s structural problems haven’t gone away, and the authorities continue to kick the can down the road. They go from one quick fix to the next… But at some point we will have to face reality, and that will be a very sour moment.”
- “In the medium term, it is much more a trading market than an investment market. Expectations for earnings growth are too optimistic… There just isn’t much firepower left to push stocks higher, and there have been some important changes in fundamentals.”
- “The biggest challenge has been greater inflation… in emerging economies…With inflation rates rising, the authorities moved away from ultra-expansive policies, and in China they started to tighten credit. That will slow these economies over time, although they are structurally sound.”
- “The problem is in the developed world. In the U.S., quantitative easing is ending due to tremendous criticism. The hurdle for launching QE3 will be very high. Europe is a special situation. The ECB [European Central Bank] is trying to reduce its balance sheet for the third time since the financial crisis of 2009. The first time they tried it triggered the Greek crisis. The second time it triggered the Irish crisis. The third time there could be problems in Italy.”
- “Greece is bust but it isn’t allowed to default. If it does so you could see a bank run throughout the European and the global banking system. The ECB and Germany are trying to force a Teutonic fiscal program on Europe. They are on a collision course with economic reality. If Greece defaults, the ECB probably will lose 30 billion to 50 billion euros. The bank’s equity capital is €10 billion. The Irish and probably Portugal and Spain would default. Germany’s Bundesbank owns more than €300 billion of European debt. A default would be worse than the collapse of Lehman Brothers.”
- “There is no painless solution. We have to let entities, even governments, default. But we have to make sure first that the banking system can handle its clients’ defaults… In the European banking system, equity capital is only 3% of assets. In the U.S. it is 4.5%. Raising banks’ equity-capital ratios is the only way to solve the problem in the long run.”
- “We missed the chance during the financial crisis. I would have handled the whole crisis differently. I would have nationalized the banks and not allowed them to pay any dividends or big bonuses. First they would have to improve their equity-capital positions. This would go hand in hand with extremely low growth.”
- “The fiscal authorities have to support the system. But instead of wasting money to boost consumption, they should be spending on investments that will bear fruit long term. By the middle of the decade at the latest, we will have a major crisis, bigger than 2008. Several countries will default, particularly in Europe. Quasi-fixed exchange rates between the U.S. and China will start to unravel, which will force the U.S. dollar down tremendously. It will push bond yields up and stocks down.”
- “From Asia to Europe to the U.S., all the important economic indicators are rolling over. Some blame the Japanese tragedy; others, the weather. It is more than that. It is the result of policy decisions. Economic growth could slow to a crawl well into early next year. The stock market isn’t priced for that. Analysts will cut their earnings estimates. There is 20% downside risk from the market’s intraday May high. Once the economic news turns decisively disappointing, the authorities will come to the rescue and try to stimulate again. That is when a trader can move in on the long side for a rally at year end.”
- “Those who have to own stocks should buy pharmaceuticals, health care and consumer staples rather than cyclicals.”
If you read the full article, you can get other well-studied opinions. There is Abby Joseph Cohen, Marc Faber, Scott Black, Mario Gabelli, Archie MacAllaster, Bill Gross, Oscar Schafer, Meryl Witmer, and Fred Hickey. For my money, Felix Zulauf offers the most insightful non-ideological economic commentary and the most actionable investment advice.
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